Weekly Market Commentary By H.E.R.O. (9 to 13 Nov 2020)
During the week ended 13 November 2020, MSCI ACWI All World index +2.5%, NYSE FANG+ index -4.1%, Gold (physical spot in USD) -3.2%. Since the recent inception on 28 August 2020, MSCI ACWI All World index +3.8%, S&P 500 +2.2%, Euro Stoxx Tech index -5.8%, Shanghai Composite index -2.8%, Gold (physical spot in USD) -3.9%, while popular big cap tech and innovation-themed companies Visa -2.4%, Apple -4.4%, Microsoft -5.4%, Facebook -5.7%, Gilead -7.2%, PayPal -7.8%, Netflix -7.8%, Amazon -8%, Mastercard -8.5%, Adobe -9.1%, Alibaba -9.7%, Intel -9.9%, eBay -10.3%, Netease (China’s internet gaming giant with S$82 billion market cap, with its gaming revenue around half the size of Tencent’s) -12.5%.
The separate equity portfolios of H.E.R.O. Innovators of our clients generated around +49% in average returns, as at 13 Nov 2020, since the H.E.R.O. research methodology was provided for and implemented in March 2020, vs MSCI ACWI All World index +36.4% and Singapore STI index +7.2% over the same corresponding period.
- Key contributors during the week were led by: (1) Japan's #1 Technical E-Manual Database SaaS Innovator (+11%), (2) Finland’s #1 Market Leader in Specialized Cloud-Based ERP and Accounting Software Solutions for Construction, Building Services Engineering and Manufacturing Companies (+9.6%), (3) Nordic Global Market Leader in Ophthalmic Diagnostic and Screening Products (+5.1%), (4) Japan’s #1 Shareholder Register Data Analytics & Consultancy Firm (+4%), (5) Japan & Global #1 Online Medical Platform ("Facebook & LinkedIn for Doctors") (+3.8%)
Following the breakout of the Pfizer-BioNTech vaccine news on Monday that it was more than 90% effective in preventing the virus, which provoked unbridled optimism over full economy reopening soon, the week saw the most extreme ever rotation out of tech stocks into cyclicals, a historic 15-sigma standard deviation event that happen every 1.090e+048 years. Tech, defensive names and havens (gold, yen, etc) corrected significantly, while cyclicals, banks, aviation-travel-hospitality, and the worst COVID-beaten down zombie stocks with the weakest balance sheet/worst quality gained massively.
The vaccine-induced rally in Cyclicals faded over the end of the week as: (1) questions about the Pfizer-BioNTech vaccine grow; (2) odds of a massive fiscal stimulus for the U.S. economy collapsed, sending the 10Y UST yields to fall; (3) surging virus infections and hospitalizations in US and globally, while a broadly available effective, safe and durable vaccine, mass immunization and full economy reopening remain many months away. Tech and “work-from-home” (WFH) stocks, led by the FANGs, are deemed “quality” stocks, with strong balance sheets, and also “growth” stocks, with well-protected profits, providing the margin of safety in long-term valuation to generate true “value”. Cyclicals and “cheap” Value Trap stocks have lagged behind prior to, and during, the crisis, due to weak structural decline in growth and poor balance sheet. Although a vaccine may help the overall economy return to trend growth after a protracted period, the key factor is that the trend growth rate of the Cyclicals has been deteriorating prior to the pandemic and unlikely to magically improve significantly in the months ahead.
Besides the problem of whether the Pfizer-BioNTech vaccine can be made broadly available across the population given the distribution, storage and logistics challenges of the vaccine, which requires ultra-cold facilities and special transport cooler boxes that keep the vaccine at the necessary -70 degrees Celsius, infrastructure that are lacking in developing countries and even in many parts of the U.S., as well as the big unknown that no one knows how long the immunity generated by these vaccines will last (a week? a month?), a question which Pfizer-BioNTech avoided answering, some of the even bigger questions include:
(1) Vaccine triggers potential autoimmune disorders: The “messenger RNA” (mRNA) technology behind the Pfizer-BioNTech vaccine has never produced an approved vaccine in history. The concern is that mRNA vaccines could trigger a generalized immune response (interferon, etc.) rather than just a specific immune response to a specific virus (antibodies, etc.). A conventional vaccine triggers the production of a specific antibody that "recognizes" a specific invader. In other cases, the immune system can activate an "all hands on deck" generalized response. The danger is that the mRNA could trigger an "all hands on deck" response that could then cascade into autoimmune disorders in which the immune system goes haywire and starts attacking the body's own cells rather than limiting its destructive capabilities to foreign viruses, bacteria, etc.
(2) Vaccine ends up helping the virus to spread: A big unknown remains the vaccine’s effectiveness in stopping transmission of the virus. The vaccine could end up helping the virus to spread if the people who get vaccinated remain capable of carrying and transmitting the virus. While the Pfizer-BioNTech candidate has shown major promise in preventing sickness, there is as yet little indication it is effective at stopping the spread of infection among people. The Pfizer-BioNTech vaccine and others might provide just functional immunity—protecting people from the full-blown disease but not from carrying the virus. Functional immunity may also be what people get from being infected by the disease itself. They can catch it again, but will have fewer, if any, symptoms. Animal studies which have been done ahead of time so far, including some challenge studies in monkeys, suggest that this class of vaccine may not prevent transmission.
(3) Mutated virus renders vaccine to be ineffective: In addition to the new coronavirus variant D614G spreading across Europe that's more infectious, the tail risk of the mutated virus in Danish mink that jumped back to humans and the possibilities of such new human-to-animal-to-human mutations could render the vaccine(s) to be impotent.
China tech stocks, led by Alibaba, tumbled in a US$260 billion selloff during the week after Beijing released on Tuesday the 22-page draft regulation “Antitrust Guideline Proposal on Marketplace Models” targeting internet platform giants, especially centering around the dominance and risks of Alibaba and Tencent’s fintech and payments business. Regulators are implementing measures that treat these big technology platforms more like banks to curtail systemic risk in risky online lending, resulting in capital requirements for reserves that were imposed on Ant Group (a 15-fold shortfall in capital requirement in the loans facilitated by Ant on the balance sheet of its microlending business which contributed 40% of its revenue and most of its overall profits) and challenges for JD.com’s IPO listing of its fintech business. Hundreds of billions in impairment writedowns will be forthcoming in the months ahead, if auditors were true and fair.
Regulations will be established to curb anti-competitive behavior such as colluding on sharing sensitive consumer data, alliances that squeeze out smaller rivals and subsidizing services at below cost to eliminate competitors. Regulatory measures will also deal with “forced exclusivity” that limit competition, which will impact, for example, online delivery and online travel companies. Regulations also target the use of personalized targeting on product and content recommendations, and livestreaming marketing content, as well as biased algorithm-based pricing, which will adversely impact ecommerce and social media/livestreaming companies.
Companies that operate the Variable Interest Entity (VIE) - a vehicle through which virtually every major Chinese internet company attracts foreign investment and lists overseas - to apply for specific operating approval. The VIE framework, which has been operating in a grey area in China, rests on shaky legal ground and foreign investors have been perennially nervous about their bets unwinding overnight. There is also uncertainty surrounding the new rules that will chill investment, acquisitions and venture capital funding. It is highly likely that the guidelines will bring about the eventual splitting off of subsidiaries.
China also saw a series of high-profile default in its high-yield state-backed corporate bonds which triggered a plunge in prices during the week as international and onshore investors grappled with the prospect of China’s central government stepping back from its traditional role as a safety net for local government businesses, and systemic credit and financial risk spills over and spreads throughout the economy, highlighting once again the fragile financial foundation of its economic recovery.
Our portfolio companies have shown resilience and scalability during this tumultuous environment and the management continue to make key strategy decision to expand their market leadership in their respective fields. The quiet HE.R.O. innovators have invested wisely in innovations that sharpen their exponential competitive edge for long-term value creation, strengthened their market position in the value chain that supercharged their cashflow dynamics, developed new channels, new markets and new customer base for revenue growth while improving their profitability at a time when most businesses are struggling, and nurtured their human capital and corporate culture to foster innovation and ESG sustainability.
While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.
Interesting Readings to be a Better Investor & Person
Adversity As Opportunity: Reboot Podcast Episode #136 with Marcus Aurelius Anderson
The Reboot podcast showcases the heart and soul, the wins and losses, the ups and downs of startup leadership. On the show, Entrepreneurs, CEO’s, and Startup Leaders discuss with Jerry Colonna the emotional and psychological challenges they face daily as leaders.
Joining Jerry on this episode of the Reboot Podcast is Marcus Aurelius Anderson, author of The Gift of Adversity: Overcoming Paralysis and Pain to Find Purpose. While preparing to deploy with the US Army, Marcus suffered a severe spinal cord inquiry which left him paralyzed from the neck down. In this conversation, Marcus shares how turning to gratitude provided the antidote to the denial and anger he felt in the aftermath of his accident, describing how his paralysis forced him to literally stand still and courageously, tenderly examine his life with honesty. Jerry and Marcus chat about times of hardship and the gift of opportunity and inquiry that lies in adversity, if only we are willing to see it.
The Gift of Adversity: Overcoming Paralysis and Pain to Find Purpose Paperback – October 23, 2017
by Marcus Aurelius Anderson (Author), Lacy French (Editor), Rachel Williams (Photographer)
While preparing to deploy with the U.S. Army Marcus suffered a severe spinal injury that left him paralyzed. After dying on the operating table twice, the surgeons saved his life, but told him he'd never walk again. Having no other option, Marcus started doing some brutally honest soul searching, looking for the lesson to be learned from his injury. Once he started seeing his Adversity as a gift instead of a curse, something miraculous began to happen... "The Gift of Adversity" tells the inspiring story and lessons learned from overcoming pain and paralysis to find purpose. Based on Marcus Aurelius Anderson's life and TEDx talk, "The Gift of Adversity" gives functional and inspiring wisdom that can be applied in personal development, motivation, and achievement.
Marcus Aurelius Anderson is an author, TEDx speaker & Keynote Speaker, Executive Mindset Coach to CEO's, Leaders and Entrepreneurs, Host of the #1 New and Noteworthy "Epic Achiever" Podcast and the World's foremost Authority on The Gift of Adversity. While preparing to deploy with the U.S. Army, Marcus suffered a severe spinal injury that left him paralyzed. After dying on the operating table twice, the surgeons saved his life, but told him he'd never walk again. Having no other option, Marcus started doing some brutally honest soul searching, looking for the lesson to be learned from his injury. Once he started seeing his Adversity as a gift instead of a curse, something miraculous began to happen... Marcus now speaks, writes, inspires and teaches others to overcome their own Adversity and actualize their personal definition of success. His TEDx talk “The Gift of Adversity” tells of how we can use our Adversity to make us into better leaders, citizens and human beings.
|The H.E.R.O. Investment Framework
The H.E.R.O. framework, methodology and strategy are powering equity portfolio asset for our clients. The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators is the only equities strategy in the market that focuses on both dividend yield and innovation-driven capital gains to enhance total shareholders’ returns. It is also the only dividend-yielding equities strategy in the market that is entirely not dependent on and with zero exposure to: (1) cyclicals (concentrated in economically-sensitive and rate-sensitive sectors such as financials, property & construction, energy & materials) that may not be resilient in economic downturns, and (2) cheap-gets-cheaper yield- and value traps. It also applies the proprietary forward-looking fact-based accounting fraud detection system that was pioneered and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS), to mitigate downside risks which escape detection by typical western-based forensic tools.
I. Strategic Focus on Quiet Innovators & The H.E.R.O. Investment Framework
H.E.R.O. is operationalized into a systematic 4-step investment process and investment framework powered by sustainability & ESG principles to identify the winners, to distinguish between the true innovators and the swarming imitators, between the devoted missionaries forging a greater Purpose and the mercenaries.
We use the framework and positive criteria of the United Nations Sustainable Development Goals (SDGs) to integrate environmental, social, and governance (ESG) considerations into the research and investment process in selecting companies that generate sales in products and services that contribute to the achievement of the UN SDGs. The central focus of our impact investing is on innovators who contribute to the UN SDG Goal 9: Industry, Innovation, and Infrastructure — “Build resilient infrastructure, promote inclusive and sustainable industrialization, and foster innovation”.
H.E.R.O. is unique in eliminating the downside risks from accounting tunneling fraud and misgovernance through unusual related-party transactions, consolidation accounting craftiness (opportunistic shifting of expenses and debt into unconsolidated entities), and hidden balance sheet liabilities at the wider pyramidal business group level etc., which escape detection by western-based forensic tools through a proprietary forward-looking fact-based accounting fraud detection system developed by KB, and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS). For instance, prevalent across Asian companies, previously Big-4 audited “cash” in the balance sheet are often misclassified “cash equivalents” disguised from improper short-term related party loans employed by the insiders to expropriate or tunnel out cash from the company after initially propping up financial numbers artificially to create false positive signals to lure in funds.
|II. Be Stronger, Wiser & Kinder By Participating in the Quiet Innovators' Quest to Purpose
“Innovators” are companies that generate sales in technologically enabled new products and services that potentially transforms the way the world works. We seek to identify companies capitalizing on innovation in offering faster, cheaper, more productive, more cost effective, more compelling products and services, or that are enabling the further development of an innovation theme in the markets in which they operate.
Not only do the H.E.R.O. innovators generate high profitability at the inflection point of their exponential growth trajectory, more importantly, they are governed by a greater purpose in their pursuit to contribute to the welfare of people and guided by an inner compass in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure, in continuing to do their quiet inner innovation work, persevering day in and day out.
|II. Quiet Innovators Thrive in Stormy Times
Prepare and position a winning portfolio for a post-pandemic world with innovators who thrive in stormy times and transform crises and trauma into opportunities for the future. The coronavirus crisis has helped accelerate innovation and enhanced the leadership of innovators. Market positions are not redistributed during sunny and calm times, but during times of crisis. The pandemic crisis has changed the behavior of both consumers and businesses. Companies offering faster, cheaper, more productive, more cost effective, more compelling and innovative products and services are gaining significant share.
Market leadership and resilient winners in stormy market environment and in the post-pandemic future will be much less about the overcrowded popular trades in mega-cap tech and loss-making tech/biotech, as defined by FAANGT-STAMP (U.S.: Facebook, Apple, Amazon, Netflix, Google, Tesla; Asia/China: SEA, Tencent, Alibaba, Meituan-Dianping, Pinduoduo), who also do not pay any dividends (with the exception of Apple and Tencent), and will be led more by highly-profitable quiet innovators, including dividend-yielding cloud Software-as-a-Service (SaaS) companies.
Notably, of the 90+ cloud software companies listed in the U.S., nearly all (>95%) do not pay any dividends, with many still looped in a negative free cashflow position, while the 20 global SaaS portfolio companies in the Portfolio of Dividend-Yielding Global H.E.R.O. Innovators are unique in being exceptional market leaders in their respective field with ample internal cashflow generative capacity to reinvest for higher-margin growth and still consistently produce rising dividend yield to reward shareholders.